Our research identified the primary factors that have influenced stock and bond correlations from 1950 until today. Of these, long-term inflation has by far been the most important.
Because inflation moves stock and bond returns in the same direction, the question becomes: How much inflation would it take to move return correlations from negative to positive? The answer: a lot.
By our numbers, it would take an average 10-year rolling inflation of 3.5%. This is not an annual inflation rate; it’s an average over 10 years. For context, to reach a 3% 10-year average any time soon—say, in the next five years—we would need to maintain an annual core inflation rate of 5.7%. In contrast, we expect core inflation in 2022 to be about 2.6%, which would move the 10-year trailing average to just 1.8%.
You can read more about our U.S. inflation outlook in our recent paper The Inflation Machine: What It Is and Where It’s Going. The Federal Reserve, in its efforts to ensure price stability, targets 2% average annual inflation, far beneath the threshold that we believe would cause positive correlations of any meaningful duration. It’s also well below inflation rates in the pre-2000 era, which from 1950 to 1999 averaged 5.3% and were associated with positive long-term stock/bond correlations.